What does "liquidity" refer to in financial systems?

Liquidity in financial systems primarily refers to the ease and speed with which an asset can be converted into cash without significantly affecting its price. This characteristic is crucial because it allows individuals and institutions to access cash for transactions or emergencies when needed. High liquidity means that an asset can be sold quickly, while low liquidity indicates that it may take longer to sell the asset, potentially at a loss.

For example, cash is considered the most liquid asset since it can be used immediately for transactions. Conversely, real estate or collectibles, while they may have significant value, are less liquid because selling them can take time and may require discounts to the expected price to attract buyers quickly. Understanding liquidity helps investors assess risk and make informed decisions about asset management in their portfolios.